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Monday, 16 December 2013

Bitcoin: What have you got?

In this Guest Post, Paul Van Dinther invites your best arguments against the new digital currency Bitcoins.

At the moment I am tentatively for Bitcoins, but I am very keen to hear a good argument against. Here is my own take at present.

I have not yet heard what I consider a solid argument against Bitcoins. One of the video bloggers I enjoy listening to is Peter Schiff. He appears a man with great insights and I tend to agree with many of his views. Recently however Peter and many others have taken to criticising Bitcoin, offering a range of arguments against the new digital currency that I find largely unpersuasive. I want to counter them here. (Full disclosure: I do not own Bitcoin, or gold, or gold stocks.)

Mr Schiff's main argument against digital currency is that it is not gold. Granted that for many reasons gold has proven over time to be a solid form of money. Only so much of it has ben dig up, and it’s damned hard to dig up quickly. Gold is an element, so what there is of it is not going away. Gold is both fungible and easily divisible. Gold has industrial uses, so will never lose value completely. Many alchemists have attempted to create gold and despite all the efforts, none have succeeded—it is not easily replicated. Mr Schiff’s main argument for gold is that it has this (what he calls) ‘intrinsic value.’ What exactly is this intrinsic value however?

Let's take a non-perishable item, such as a timber log. It has ‘intrinsic value.’ You can use it to make a fire or you can make things with the timber. If you have the need to cook a meal over a fire, the value of the log is the energy it contains. If you need to make a table, its intrinsic value (in the sense meant by Mr Schiff) would include its strength and beauty.

Would the intrinsic value of that log diminish if you have a big pile of logs behind the house? I argue that it doesn't. Its economic value would diminish, but not its ‘intrinsic value.’ You still need that one log for your fire needs, and the log is valued for its ability to burn for a certain amount of time.

So we might say that "intrinsic value is value in its own right"

Back to gold. Great stuff. It won't corrode, it’s a good conductor of electricity, it’s great for jewellery, and it has these other industrial uses. Gold is a pretty crap metal however in many respects--you would not want your car's transmission to be made of it, or any beams in your house. But yes, gold does have some specific intrinsic value.

But I argue that the intrinsic value of gold doesn't even get close to it's $1200 price. Yes gold is still used in manufacturing but enhanced production techniques ensure a little gold goes a longer way, at least until alternatives are found in new nano materials.

Therefore I argue that the price of gold does not represent intrinsic value at all. Instead it is a token for real world value for all the reasons so well documented. In a nutshell, gold lasts and it is rare.

The other argument against Bitcoin is that anyone could dream up a new digital currency and therefore digital currency is potential part of an unlimited supply, and no better therefore then paying with dried maple leaves. Let's see how this plays out:

I work 40 hours. I value my time and I wish to be rewarded for that time. The reward needs to be in a format that I find acceptable, and agreed on in advance of doing the work. I could choose to be paid in chickens, in gold, in dried maple leaves—or, slightly better, in US dollars, or in some new digital currency in whose continuing value I trust. If I choose to be paid in Bitcoins, then I have just placed my trust in that currency.

Now Joe Bloggs may be doing the same with a different digital currency, but the two are not directly connected. Therefore trade between me and Joe is going to be difficult. It should be clear that eventually either Joe or me will choose a different form in which to store value. Eventually, one particular digital format will leave the other formats for dead, just as VHS left Betamax dead all those years ago.

Obviously the format most secure and least inflatable will win, if not meddled with by governments.

Forget about the intrinsic value of gold for the reason already given. Why would gold not fall out of grace? It is heavy, you can't send it around electronically and, unless you are an expert, you'd have trouble to identify gold on it's pureness. Are we going to bite on coins again?

Another argument is that the Bitcoin value is very volatile. And so they are. And so too is gold. Gold doubled in value over a very short time, and now in an equally short time has all but halved from its peak. Any format of trade is subject to speculation and with that comes a certain amount of volatility. Opponents of digital currency like to gloat about how some speculator is going to lose a lot of value when the Bitcoin bubble bursts, and I agree that this is a possible scenario, but it’s no different from the poor sod that bought gold at $2000 and then saw 40% of the "investment" wiped out to the price it is today.

Bitcoin is currently a tiny player. The number of goods that are traded using Bitcoins is steadily increasing and I expect it's value to stabilise once the current speculation bubble either bursts or deflates.

There appears a lot of confusion about investment and currency. Bitcoin is supposed to be money rather than a speculative investment. Bitcoin is a vehicle to store and transfer value between it's users. Ideally, its value is stable, and that is certainly a criterion for me before I would choose to store my value that way.

To me, the bottom line is simple. The market decides what is a suitable form of currency. That is not reflected in the speculative value of the currency, but the number of traders willing to store or trade their value in that format.

There is one reason only why I remain reluctant to use Bitcoin. It is called unhackable but that is not enough to convince me. It seems to me inevitable that at some point someone will find a way either to hack it, or to mine it more efficiently. However a solid track record of several decades could sway my view on that.

So, what are your views?

Paul van Dinther is a software developer and part-time Libertarian who likes the underdogs. Despite his mature age, he still asks "Why" all the time.

18 comments:

I've been following Bitcoin since before it gained the eye of the MSM. I admit it's value is nothing other than the hope someone will pay more for it tomorrow than you paid for it today, and that with no government guarantee to the nation's taxpayers it is even more a fraud than government printed fiat money, but philosophically I'm LOVING it. It's rattling the cages of every taxing authority that cannot use its vast array of snooping powers to unwind individual transactions, and hence, it's frightening the politicians.

To the IRD when they read this - as they read my blog - I hold no Bitcoin. (Mainly because I couldn't figure out how to mine the damned stuff :) )

I have been a fan of the concept of bitcoin since I first heard about it in 2011 (in fact I started the first NZ exchange at bitnz.com).

It is important to make the distinction between bitcoin (the currency unit) which does not have any utility itself and Bitcoin (the protocol and network) which allows a global distributed ledger apart from any central clearing house (and the counter party risk that goes with that). This is a huge technology, just as email revolutionised communication this can revolutionize finance and it has much more possible uses other then just currency.

It only, in my mind, has a philosophical value (and I love it for that): there's no way to apply economic analysis to it outside simple demand and supply. Unfortunately, with it already banned in China, I suspect Western taxing authorities will at some stage set to it in a passion akin to the state's war on drugs. They can't leave it unhindered in the wild after the next Western economic collapse, which may not be that far off, and will make August 2008 look like a walk in the park. If BT is a bubble, so is almost every asset class in the West given the cure for the GFC was more of what caused it.

Bitcoin on it's speculative value which I agree is rubbish since you can't buy much with it yet

Not true, BitCoin is easily converted to cash - at surprisingly high rates right now.

It's also a bit like gold for those who care in that there is a limited supply - for some reason (I don't know if it was arbitrary design or a consequence of the cryptographic organization) there's a limit of 21 million total BitCoins.

I suspect BitCoin will last as long as a) governments don't, as part of their general assertion of authority, assault the exchanges and b) people remain confident the protocol has not been corrupted (which would be a focus of assaults on it by authority should they take against it).

I tend to agree with you Ben, but don't just look at bitcoin. There is a reason it becomes popular now. People might revert to gold but history shows that can be outlawed too. But people always find ways. Although a bit idealistic, Have a look online for "Time banking"

A great example of invisible transactions was shown a while back on the "Grand designs" tv show where builder mates do each other "favours" off the record in order to build or improve each others houses.

Governments may be banning bitcoin but it will soon become a whack a mole game as new ways to conduct transactions continue to appear.

Fundamentally I struggle with the concept of bitcoin, because there's nothing of inherent value (what Schiff calls "intrinsic value") behind the currency at all. Sure, the gold price may fluctuate wildly due to speculation and at times its sell value may exceed it's value as a commodity - but the point is it does have a value as a commodity; a tie to something real and tangible.

I understand that until very recently the majority of gold produced in the world each year was consumed for a variety of uses, mainly in jewellery production. It's a product valued for jewellery production because it has attributes good for that purpose - it's malleable, shiny, etc. I'd be happy to be proven wrong, but I can't see how bitcoin has that same tie to reality.

Bitcoinc is anonymous? I think not."Bitcoin is not anonymous. Some effort is required to protect your privacy with Bitcoin. All Bitcoin transactions are stored publicly and permanently on the network..." http://bitcoin.org/en/you-need-to-know

Well Mark, according wikipedia only around 10% of gold is used by industry. That leaves 90% of the gold lying around for no other reason then jewelry, investment or value store. I think that a lot of jewelry is in fact used as a value store.

It is not as if my bar of gold is ever going to be useful to me for anything else but selling it. The gold price would plummet to a mere fraction of it's current price if the remaining 90% of gold is offered all at once to be consumed for it's intrinsic value.

Dinther - Not sure I follow your logic there. If gold was only worth a fraction of the current price for industrial uses, then industry wouldn't be buying it at current prices. The fact they do use it means it is worth that much to them. Also you can't equate luxury items like jewellery (where most gold is consumed) as a "store of value". Most people I know would never think of selling their wedding rings and the like when they're a bit short of cash. The jewellery means something to them, so it may not have "intrinsic value" but it does have an objective value to the private life of the owners that a piece of paper confirming your ownership of Bitcoins could never have.

Dinther - The other factor you're don't seem to consider is the extent to which the cost of mining gold determines its price. Regardless of how much the demand for gold might drop, there remains a high cost for producing gold that will limit how low the price can go in the long term.

Let's say the demand for gold reduced by 50% overnight. Initially you would see large price decreases, as the 'stockpiled' gold is sold and used up. However once that stockpile goes then you return to the fundamental economics of finding a material in the ground that is rare. Now long term the price would certainly drop, because only the 50% of gold producers who were the most efficient and had the lowest production costs would survive. But these remaining 50% will not be able to produce gold for a "mere fraction" of the cost of the others. The variance in cost between different companies and mining operations is not that dramatic.

There are some misconceptions about gold in the modern era when compared with the old 'Gold Standard' days, and today most people are placing a 'value' on the wrong thing - because things have been reversed and few people seem to realise it has all been reversed.

Back in the old days it was the UK pound note or US dollar, on the desk in front of you, which was important; - that bank note was equal to a certain amount of gold - and that amount was fixed, (and remained so for a considerable period of time.) - The gold itself was actually irrelevant.

Today you have lots of people placing a 1 ounce gold bar on the desk in front of them and thinking it is valuable and making them rich with the reasoning of "the government is printing bank notes like there is no tomorrow so having the gold bar must be safer and true wealth"

In reality, they have it all back to front.

The gold bar has little or no intrinsic value because it is equal to as many bank notes as the government is prepared to print (you want it worth $800? fine - here you go; you want it worth $1500? sure - here you are...what about $2000? or $2500 don't worry we aren't running out of banknotes, we printed a new batch this morning ...)

If you want stability, a lack of inflation or to view gold as a store of value or wealth you need to have the BANK NOTES equalling something which is fixed, not the other way around.

Detaching currency from gold was a good idea. A brilliant one. Now each country is wealthy according to it's productivity, not to dig and find gold, or to extract it from other economies, but in the expectation of its government to be able to tax its citizens on their future income/wealth (measured in national currency, tradable and convertible via forwards, futures and swap markets - fixed income and bond markets - and therefore COMPARATIVLY valuable).

Inflation is a political tool to make general tax-payers feel better. And to allocate wealth from the rich (old) to the poor soowl

Imagine, a person works for 40 years and accumulates 40 gold bars. The person dies, but population has grown from 2b when the person was born, to 7b when they die. A lot more people needing "gold" than the gold bars could handle, if everyone wants/needs to retire with 40 gold bars.

Anyway - to cut a long story short, gold was a bad idea, economics is a much better way to compete than acquisition - and bitcoin is a waste of everyone's time, as it lacks almost every feature of a useful social tool, aside from short-term anonymity and a feeling that you have "out smarted the system".

You haven't, by a long way. The social and physical cost of switching a major currency unit to based on bitcoin or anything that resembles the bitcoin network, are unimaginable.

The biggest surprise, is that the US egulators haven't come out and said so in a factual and highly detailed way. But their relative incompetence compared to other regulators, is one of the reasons we're all rushing for.something new...

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